Download U.S. Annuity Market Dynamics and Regulatory Requirements

U.S. Annuity Market Dynamics and
Regulatory Requirements
Lee Covington
Senior Vice President and General Counsel
Insured Retirement Institute
Organisation for Economic Co-operation and Development (OECD)
Roundtable on Annuities
December 6, 2012
U.S. Annuity Industry Assets
Annuity Net Assets in Billions
$1,800
$1,622
Net Assets in Billions
$1,600
$1,502
$1,400
$1,200
Variable Annuities
Net Assets
$1,000
$800
$777
$600
$400
$421
$200
$0
Source: Morningstar and LIMRA
$675
Fixed Annuities Net
Assets
U.S. Annuity Industry Sales
Industry-Wide Annuity Sales, 2006 to Present
$60.0
Doallars in Billions
$50.0
$40.0
$30.0
$20.0
$10.0
$0.0
Source: Morningstar and Beacon Research
Total
Variable
Annuity Sales
Total Fixed
Annuity Sales
Consumer Need for Lifetime Income
 Basic demographics
 Longer lifespans
 Shift from defined benefit plans to defined
contribution plans
 Rising health care costs
 Entitlement risk
 Diminished confidence
 Other risks
Basic Demographics in the U.S.
 79 million Baby Boomers (Ages 50-66)
 Americans between the ages of 60-64
grew 56% from 2000-2010 from about
10.5 million to more than 16.2 million
 Baby Boomers control more than $13
trillion in investable assets
Source: Report by the Insured Retirement Institute and Cogent Research titled “Baby Boomers and
Generation Xers: Are They on Track to Reach Their Retirement Goals?” (August 2012)
Longer Lifespans for Americans
Life Expectancy at 65
25
Additional Years
20
15
female
10
male
5
0
1940
1960
1980
2000
Year
2011
2020
2040
Source: 2012 Social Security Trustees Report; Period Life Expectancy Historical and Projected
Longer Lifespans for Americans
 Longevity > Life Expectancy
 65-year-old male: 30% chance of living
to 90
 65-year-old female: 42% chance of
living to 90
 A couple, both aged 65, has a 60% of at
least one living to 90; 30% chance of at
least one living to 95
Shift from DB Plans to DC Plans
 1985: 114,000 private-sector, employer-funded
defined benefit (DB) plans
 2011: Only 27,000 DB plans remaining
 Only 19% of U.S. workers today have access to a
employer-funded DB plan
 Workers must save using defined contribution
(DC) plans, annuities, and other savings vehicles
(tax deferred or taxed)
Source: Pension Benefit Guaranty Corp; U.S. Bureau of Labor Statistic’s National Compensation Survey
Health Care Costs Rising in the U.S.
 Rising health care costs:
 17% of GDP in 2010; 20% of GDP by 2017
 Cumulative health costs and premiums:
 Healthy 65-year-old male: $369,000 on average
 Healthy 65-year-old female: $417,000 on average
 Only 37% of Baby Boomers are confident in
covering health costs in retirement
 Only 24% of Baby Boomers are confident in
covering long-term care
Entitlement Risk
 Tremendous uncertainty regarding
U.S. government systems for retirement
income and medical payments (Social
Security and Medicare)
 Require changes to remain financially
viable
 Changes may reduce cumulative
benefits retirees receive
Diminished Confidence
 62% of Baby Boomers believe their
personal financial situation will be the
same or worse five years from now
 60% of Baby Boomers believe their
financial security in retirement will be
about the same or worse than their
parents
Source: Report by the Insured Retirement Institute (IRI) and Cogent Research titled “Boomer
Expectations for Retirement 2012: Annual Update on Retirement Preparedness” (April 2012)
Other Risks
 Market risk
 Inflation risk
 Excess withdrawal risk
 Sequence of returns risk
 Asset allocation risk
 Tax uncertainty Risk
Financial Literacy Across the World
 New research on financial literacy by:
Dr. Annamaria Lusardi
The George Washington School of Business
Director, Global Center for Financial Literacy
 Questions added to national surveys in several nations
across the world
 Financial literacy measured by understanding of three
financial concepts:
 Compounding interest
 Inflation
 Risk diversification
World Financial Literacy Key Findings
 Financial literacy lowest among young adults, the elderly,
and women.
 Financial literacy is positively correlated to retirement
planning and participation in retirement plans.
 Lack of financial knowledge results in fewer retirement
savings. Those who plan for retirement and exhibit
forward-looking behaviors, on average, accumulate more
wealth.
Source: Presentation by Annamaria Lusardi titled “Retirement Planning and Financial Literacy around the
World” (April 2012)
Importance of Annuities in Retirement
Strategy
Investors agree that annuities are a
critical part of a retirement strategy
55%
Annuity Owners
73%
2011
2012
8%
Non-Annuity Owners
17%
Source: IRI Baby Boomers and Generation Xers (August 2012)
Increased Focus on Retirement Income
Planning and Annuities
 84% of advisors say that they are having
more client discussions about
retirement income planning
 71% of advisors say that they had a
client request to purchase an annuity
during the last year
Source: IRI Baby Boomers and Generation Xers (August 2012)
Top Five Reasons to Purchase an Annuity
34%
35%
27%
2011
26%
23%
2012
19%
9%
7%
6%
1%
Guaranteed
Income
Advisor
Recommended
Tax Deferral
Principal
Protection
Inflation
Protection
Source: IRI Baby Boomers and Generation Xers (August 2012)
Consumer Need and Satisfaction with Annuities
 63% of annuity owners agree that
market volatility makes them more
likely to consider an annuity
 90% of annuity owners are somewhat
or very satisfied with their annuitybased investments
Source: IRI Baby Boomers and Generation Xers (August 2012)
Preparedness for Secure Retirement
Savings = insufficient
27.8%
No retirement savings
21.7%
Gen-Xers
Baby Boomers
65.7%
Less than $100K saved
39.1%
Source: IRI Baby Boomers and Generation Xers (August 2012)
Insufficient Knowledge of Investing
45.1%
Gen-Xers
16.2%
40.8%
Baby Boomers
"Not very" or "not at all"
knowledgeable about investing in
securities
"Very" or "extremely"
knowledgeable about investing in
securities
17.3%
Source: IRI Baby Boomers and Generation Xers (August 2012)
Retirement Planning Behaviors
Consulted a financial advisor = no
Calculated a retirement savings goal = no
40.7%
Gen-Xers
62.5%
Have not calculated a savings goal
Have not consulted an advisor
51.4%
Baby Boomers
52.8%
Source: IRI Baby Boomers and Generation Xers (August 2012)
Annuities = Good Retirement Plan
Baby Boomer annuity owners are more confident and
more likely to engage in positive retirement planning
behaviors than Baby Boomer non-annuity owners
44.3%
Calculated a retirement savings
goal
69.6%
34.8%
Consulted a financial advisor
73.7%
Baby Boomer Non-Anunity
Owners
Baby Boomer Anunity Owners
"Very" or "extremely" confident in
retirement
31.0%
53.4%
Source: IRI Baby Boomers and Generation Xers (August 2012)
Middle Class Use of Annuities – High Confidence
 Eight in 10 buyers of nonqualified annuity
contracts have annual household income of less
than $100,000; that includes 64% who earn less
than $75,000.
 Nine in 10 Baby Boomers who own annuities
believe that they are doing a good job preparing
for retirement.
Source: IRI Retirement Preparedness Report (April 2012)
Educational and Advocacy Efforts
 The President’s Middle Class Task Force
recommended:
“Promoting the availability of annuities
and other forms of guaranteed lifetime
income, which transform savings into
guaranteed future income, reducing the
risks that retirees will outlive their
savings or that their retirees’ living
standards will be eroded by investment
losses or inflation.”
U.S. Government Policy Initiatives
 Departments of Labor and Treasury
joint initiative to increase access to
lifetime income options
 Lifetime Income Disclosure Act (S.267
and H.R.677)
Regulatory Requirements
Consumer Protection
Life Cycle: Consumer Protections
Pre-sale / Point of sale
Post-sale
Accumulation and withdrawal
phases
 Product is state approved and SEC
 Updated prospectus delivery
registered
 Quarterly / Annual Statement
 Agent is authorized to sell (insurance
delivery
licensing & FINRA registration, if
 Consumer begins taking annual
applicable)
income amount from covered asset
 Agent training requirements
account
 Product marketing material authorized
under insurance law and FINRA
guidelines
 State Insurance and FINRA suitability
review
 Prospectus / State Disclosure
 Annuity Buyer’s Guide, if applicable
 Delivery of contract / certificate
Regulatory Requirements
Solvency Protection
Life Cycle: Solvency
Pre-sale / Point of sale
Post-sale
Post-sale
Accumulation and
withdrawal phases
Annuity payments
phase
 Insurance company establishes  Statutory reserve and
investment guidelines and
capital requirements for
restrictions on the assets to
inforce contracts
which protection is applied
 Management of financial
pre-sale
risks through various
 Product design and pricing
activities, including hedging
considers risks and costs
programs
associated with the product,
 Management of operational
and limits exposure to certain
risk through various
risks (longevity, behavioral,
activities, including
and capital markets) pre-sale
monitoring and enforcing
 Insurance company assumes
adherence to investment
management of financial and
guidelines and restrictions
operational risks at point of
sale
 Hedge activities cease and
hedge assets are released
 Statutory reserve is
released and a fixed
immediate annuity reserve
is put up
 Remaining risk in annuity
payments phase is
primarily longevity risk
 Capital markets risk
associated with interest
earned on General
Account reserve assets
remains
Enterprise Risk Management
Solvency
 U.S. Regulatory Solvency Framework
 Seven principles of regulatory solvency framework
 Statutory Reserve and Capital Guidance
 Risks and Risk Management Associated with Guarantees
 Financial Risk Profile
 Asset Parameters
 Enterprise Risk Management
 Risk Capacity
 Own Risk & Solvency Assessment (ORSA)
U.S. Regulatory Solvency Framework
 Regulatory oversight of insurer solvency occurs within a comprehensive
framework
 Seven principles of regulatory solvency framework for insurance:
 Regulatory Reporting, Disclosure, and Transparency
 Off-site Monitoring and Analysis
 On-site Risk-focused Examinations
 Reserves, Capital Adequacy, and Solvency
 Regulatory Control of Significant, Broad-based Risk-related
Transactions/Activities
 Preventive and Corrective Measures, Including Enforcement
 Exiting the Market and Receivership
U.S. Regulatory Solvency Framework
Capital and Reserve Guidance for Variable Annuity Guarantees
AG 43 and RBC C-3 Phase II provide for rigorous measurement and certification of reserves and capital

Calculations based on Conditional Tail Expectation (CTE)
 CTE is a statistical measure which provides information about the tail of a distribution.
CTE(x) is equal to the average of the worst (100-x)% of results
 AG 43: Reserve based on CTE 70, the average of worst 30% of scenario results
 C-3 Phase II: Risk-based capital based on CTE 90, the average of worst 10% of scenario results

Stochastic scenarios calibrated to NAIC RBC C-3 Phase II criteria

A minimum reserve & capital requirement based on the Standard Scenario, which
includes prescribed assumptions for mortality, policyholder behavior, investment
returns

Hedging can be reflected only if a Clearly Defined Hedging Strategy, certified by a
financial officer of the company, is in place; the assumed Effectiveness Factor can
be no more than 70%

Appointed Actuary opines annually on reserve adequacy and compliance with
Actuarial Standards of Practice
Enterprise Risk Management
 Enterprise Risk Management
Risk Capacity
Own Risk & Solvency Assessment (ORSA)
Enterprise Risk Management
ERM & Risk Capacity
 ERM is a framework for strategic decision making, risk management
activities and governance
 Insurers have ERM practices in place to identify, measure, and manage risk
exposures across all of their activities
 The American Academy of Actuaries recommends that insurers issuing
variable annuity guarantees have robust ERM practices in place
 Risk Capacity
 A key consideration within an insurer’s ERM framework is risk diversification
and risk capacity
 Diversity in business mix provides for offsetting risk exposures
 “Monoline” enterprises take on significant risk concentration – regulators
would have the ability to disallow filings by monoline variable annuity
guarantee issuers
Enterprise Risk Management
Own Risk & Solvency Assessment (ORSA)
 ORSA is one element of a broader ERM framework
 ORSA Summary Report will be supported by internal risk management
materials and more detailed underlying documentation
 At a minimum ORSA Summary Report should cover:
 Description of risk management framework
 Assessment of risk exposures
 Group risk capital assessment
 Prospective solvency assessment
 Goals:
 Foster an effective level of ERM at all insurers
 Provide a group-level perspective on risk and capital